The Short Term Rental Loophole

In the last two newsletters, we talked about the incredible tax benefits that real estate provides and the requirements you must meet to be eligible for them. So what happens if you or your spouse are not able to qualify as a real estate professional, therefore, limiting the amount of tax benefits that real estate can provide you? The short-term rental loophole is your last chance to take advantage of all those benefits. This loophole unlocks the key to offsetting your active income through real estate investing no matter your situation. Whether you are a w2 employee at Apple, a full-time real estate investor, or run your own business there is a game plan designed for you to take full advantage of the tax benefits real estate provides. Learn the strategy that applies to your scenario and use it to reduce or eliminate your biggest expense, taxes. The fewer taxes you pay the faster financial freedom comes.

Why Does This Loophole Exist?

Typically owning a rental property is treated as a passive activity and the losses generated by the property are treated as passive losses. Passive losses can not be used to offset active income like a w2 for example. In order to offset active income you must show that you are materially participating and not just deploying capital to generate a return. In the scenario of a short-term rental property, you are much more involved in the day-to-day operations than you would be if you owned a long-term rental property. Operating a short-term rental is the same as operating a long-term rental but with more work and more steps. If you own long-term rentals you must qualify as a real estate professional and prove material participation to unlock all the tax benefits real estate provides. With short-term rentals, you don’t have to jump through as many hoops and material participation is easier to achieve. Running a short-term rental is not a passive activity by any means. Because running a short-term rental requires more involvement you are more likely to be eligible to use the losses created by the property to offset other active gains.

So How Is This Different Than REPS(Real Estate Professional Status)?

REPS requires you to essentially live and breathe real estate. You have to meet a bunch of hourly requirements and pass the material participation test. Even if you meet those requirements more than 50% of the work you do in a year has to be in real property trades or businesses. This eliminates a lot of people from being eligible. The short-term rental loophole is great because there are no hourly requirements and 50% rules etc. You can work full-time as a w2 employee or spend 90% of your time growing your business while still being able to use the short-term rental property depreciation to offset your active w2 or business income. If you don't want your life to revolve around real estate it shouldn’t have to but you should still be able to receive all the tax benefits that come with it because you’re a real estate investor. The short-term rental loophole makes that all possible.

How To Qualify

There are six ways to qualify for the short-term rental loophole.

1. The average period of customer use for such property is seven days or less.

2. The average period of customer use for such property is 30 days or less, and significant personal services are provided by or on behalf of the owner of the property in connection with making the property available for use by customers. This could include services that a hotel would provide, such as daily cleaning or meals.

3. Extraordinary personal services (same as above) are provided by or on behalf of the owner of the property in connection with making such property available for use by customers (without regard to the average period of customer use). 

4. The rental of such property is treated as incidental to a non-rental activity of the taxpayer.

5. The taxpayer customarily makes the property available during defined business hours for nonexclusive use by various customers.

6. The provision of the property for use in an activity conducted by a partnership, S corporation, or joint venture in which the taxpayer owns an interest is not a rental activity.

Method #1 is the most popular because it requires the least amount of work and interruption in your day-to-day life. All you have to do is run a short-term rental where the average rental length is 7 days or less. It’s that simple. If you find that method #1 is not the best option for you then any of the other five options will provide the same benefits but generally require more work.

Why Real Estate Is So Powerful

Tax benefits are one of the most overlooked yet powerful benefits of investing in real estate. The ability to offset your active income regardless of your career situation is something special and unique to real estate. Whether you qualify as a real estate professional or use the short-term rental loophole the tax benefits of real estate are clear and abundant. While many people compare the returns in real estate to the returns in the stock market or other investments they don’t usually account for the tremendous tax benefits. Once the tax benefits are added into the equation real estate becomes the obvious choice when compared to any other investment. Why pay more taxes than you have to? The tax code is designed to provide incentives for using your money and investing in a way that the IRS wants you to. Those incentives come in the form of tax benefits that you should absolutely be taking advantage of. The combination of cash flow, principal pay down, appreciation, and depreciation that real estate provides is unmatched by any other investment in the world.